Here Is Why Bond Yields Can Pop The Hyper-Speculative Stock Market Bubble

Here Is Why Bond Yields Can Pop The Hyper-Speculative Stock Market Bubble

bond yields
Here is Why Bond Yields Can Pop The Hyper- Speculative Stock Market Bubble Image: iStock

All the signs are there for a bubble pop, stock market observers say. Investors are scurrying around showing all of the behaviors associated with previous stock market bubbles, including aggressive equity allocations and risk leverage.

It’s a scary time. Investors are holding close to the highest levels of equities on record, Seeking Alpha reported. And they are leveraging their investment risk by holding the highest levels of “call options” in history.

Call options give buyers the right to buy a stocks, bonds and commodities at a specified price within a set time. A call buyer profits when the asset increases in price, according to Investopedia.

“My confidence is rising quite rapidly that this is, in fact, becoming the fourth ‘real McCoy’ bubble of my investment career,” said British investor Jeremy Grantham, co-founder and chief investment strategist of Boston-based asset management firm Grantham, Mayo, & Van Otterloo, during a CNBC interview. “The great bubbles can go on a long time and inflict a lot of pain, but at least I think we know now that we’re in one.”

One sign is that interest rates continue to rise, and the speculative stock market bubble continues to inflate. Early on Feb 24, long-term interest rates spiked. The yield on the 10-year Treasury pushed to 1.43 percent. The yield on the 30-year nearly hit 2.3 percent. It was the highest yield since the market collapse caused by the pandemic, CNBC reported.

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Some experts think rising rates will force the Fed to tighten monetary policy sooner than expected; other observers disagree.

But as soon as interest rates spiked Feb. 25, gold sold off. Experts said it was an automatic response to the spike in bond yields.

A bond yield is the return that an investor gets on that bond. A fall or rise in interest rates in an economy pushes up or pulls down bond prices, according to Business Standard.

Bond yields are now increasing because there is an excess supply of bonds due to massive deficits. The Fed is buying a lot of bonds, but they ain’t buying enough. So there are extra bonds, pushing the price lower.

Bond yields are inversely correlated with bond prices. When the price drops, interest rates increase.

“Treasury yields have been on a tear recently and growth stocks have taken the brunt of the reaction,” Barron’s reported. Since Feb. 10, when Treasury yields began their most recent race upwards, the Russell 2000 Growth Index, an index of smaller, less profitable names, is down more than 5 percent. Meanwhile, the large-cap Vanguard S&P 500 Growth Index Fund ETF (VOOG) is down 3 percent.

Such bond yield activity can pop the current hyper-speculative bubble. This would mean an end to the biggest bubble in history, marking a loss of a five-year return.

The bond market has become its own beast. “There are $17 trillion in negative-yielding bonds outstanding. Someone (and not just central banks) owns those along with many trillions more yielding under 1 percent,” Forexlive reported.

On the other hand, it is possible for the bull market to survive rising inflation and bond yields.

History shows that when yields are rising “for the right reasons,” tech shares and cyclically sensitive stocks tend to thrive, according to investment bank and financial services company Raymond James Financial.

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The right reasons include “improving economic growth and a ‘healthy’ rise in inflation,” said Larry Adam, chief investment officer for the private client group at Raymond James, in a Market Watch report.

“Since 1990, during rising-rate environments, the more cyclical sectors have outperformed,” Adam said. “The average annualized outperformance relative to the S&P 500 and the percentage of time it outperforms the S&P 500 is largest for the tech, consumer discretionary and industrials sectors — three of our preferred sectors,” while higher dividend-yielding sectors like utilities, real estate, and consumer staples tend to underperform.